48.11 Recovering Costs of a Tax Dispute

In a tax dispute, you may believe that the IRS has taken an unreasonable position, forcing you to incur legal fees and other expenses to win your case. You may be able to recover all or part of—

A judgment for reasonable litigation costs will not be awarded in any court proceeding if you did not exhaust all IRS administrative remedies. A refusal by the taxpayer to agree to an extension of time for a tax assessment is not a bar to an award, but unreasonably delaying the proceedings is.

You may not recover costs if your net worth at the time the action begins exceeds $2 million. The $2 million net worth limit applies separately to each spouse in determining whether a married couple filing jointly is entitled to recover legal fees. No recovery is allowed to sole proprietors, partnerships, and corporations if their net worth exceeds $7 million or they have more than 500 employees.

To receive an award, you must “substantially prevail” as to the key issues in the case or the amount of tax involved. If you do, you will be entitled to a recovery unless the IRS proves that it was “substantially justified” in maintaining the position that it did. You may be treated as the prevailing party if a court determines that your liability is equal to or less than an amount that you offered in settlement. The offer must be considered a qualified offer made during a period that begins on the date of the first letter of proposed deficiency allowing for an IRS administrative appeal and ends 30 days before the date first set for trial.

The Tax Court and other courts have interpreted “substantially justified” to be a reasonableness standard. The IRS is presumed not to be “substantially justified” if it does not follow its own published regulations, revenue rulings, procedures, notices, announcements, or a private ruling issued to the taxpayer. The IRS may try to rebut the presumption. A court may also consider whether an IRS position has been rejected by federal courts of appeal of other circuits in determining whether the IRS position was substantially justified.

Reasonable administrative costs include IRS fees, reasonable fees for witnesses and experts, and attorneys’ fees subject to the annual limit; see below. The IRS determines the amount of such an award, which may include costs incurred from the date the IRS sent its first letter of a proposed deficiency allowing you to ask for an administrative appeal. For an award of administrative costs, you must file an application with the IRS before the 91st day after the date on which the IRS mailed you its final decision. To appeal a denial of your application, you must petition the Tax Court within 90 days from the date the IRS mailed the denial.

Planning Reminder

Recovering Attorneys’ Fees

Attorneys’ fees include the fees paid by a taxpayer for the services of anyone who is authorized to practice before the Tax Court or IRS.

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Reasonable litigation costs include reasonable court costs, fees of witnesses and experts, and attorneys’ fees. Fees of witnesses may not exceed the rate paid by the U.S. government. For attorneys’ fees incurred in 2012 the limit is $180 per hour (same limit as for 2009-2011). The court may also increase the award for attorneys’ fees to account for special factors, such as the difficulty of the issues and the availability of local tax expertise. However, an attorney’s general expertise in tax law or experience in tax litigation is not in itself a special factor warranting a higher fee award.

You may not recover attorneys’ fees if you represent yourself (pro se). However, you are still entitled to recover fees for witnesses and experts. If you represent a prevailing taxpayer on a pro bono basis or for a nominal fee, a court may award you or your employer reasonable attorneys’ fees.